Labor Market Overview(Part 2)

The Labor Market

• Labor markets determine – Terms of employment

• Earnings versus total compensation

• Working conditions

– Levels of employment

• These are determined by the interaction of demand and supply

Demand for Labor

• Derived demand– In product markets, firms produce the output level

where MR=MC

– MC depend upon prices of inputs, productivity, and technology

– Output is produced using least cost combinations of inputs

– So, demand for output or output price, wage rates, prices of inputs, and technology all determine demand for labor

Figure 2.6 Labor Demand Curve (based on data in Table 2.3)

Movements along the Labor Demand Curve

• Changes in wages:– As wages rise or fall, the firm weighs to effects

• Scale effect – wages affect overall MC causing optimal output and hence quantity of labor demanded to change

– W↓ → MC↓ → Q↑ → Qdl↑

– W↑ → MC↑ → Q↓ → Qdl↓

• Substitution effect – as wages change the relative cost of labor compared to capital (or other inputs) changes

– W↓ → W/C↓ → Qdl↑ → Dk↓

– W↑ → W/C↑ → Qdl↓ → Dk↑

Shifts in the Labor Demand Curve

• Changes in demand for the product or product price:– As P↑ → MR↑ → Q↑ → scale effect →DL↑– As P↓ → MR↓ → Q↓ → scale effect →DL↓

• Changes in the price of capital (or other inputs)– As C↑ → MC↑ → scale effect → DL↓

→ W/C↓ → subst. Effect →DL↑– As C↓ → MC↓ → scale effect → DL↑

→ W/C↑ → subst. Effect →DL↓Therefore, the total effect of changes in C is ambiguous.

Figure 2.7 Shift in Demand for Labor Due to Increase in

Product Demand

Figure 2.8 Possible Shifts in Demand for Labor Due to Fall in

Capital Prices

Market, Industry and Firm Demand

• Market : sum all firm demand curves for labor across all industries

• Industry : sum of firm demand curves across an industry group

• Firm : the demand curve for a single producer• The scale and substitution effects are likely to vary

between the firm, industry and market and in the long-run versus the short-run. Therefore, the responsiveness of labor demand to its determinants will also likely vary.

Supply of Labor

• The supply of labor comes from the household/individual decision about leisure versus goods and services

• Assuming that an individual decides to work, wages affect the supply of labor in two ways:– W↑(↓) → opportunity cost of leisure↑(↓)→ Subst. Effect away

from (towards) leisure towards (away from) Goods and Services or more (less) work → Qs

l↑(↓)– W↑(↓) → income effect →purchase more leisure (less work) and

more goods and services

• Generally, we assume that the substitution effect outweighs the income effect and supply of labor is upward sloping.

• Changes in relative wages among different occupations could also change a person’s occupational choice. This effect would generally support an upward sloping supply curve for an industry, but it would likely have little effect on the overall market supply of labor.

Market Supply

• Assume that the person has decided to work. The decision is:– What occupation?

– Which employer?

• If wage rates for a given occupation rise, ceteris paribus:– The opportunity cost of working in other occupations will rise.

Thus, the number of people choosing the given occupation will increase → upward sloping-supply → a movement along the supply curve.

– If wages rates in any “related” occupation change, the supply curve will shift.

Figure 2.9 Market Supply Curve for Secretaries

Figure 2.10 Shift in Market Supply Curve for Secretaries as Salaries of

Insurance Agents Rise

Supply to Firms

• The supply to firms depends upon whether firms have any market power in the labor market.– Many firms or competitive markets OR wage takers: supply

to the any one firm is perfectly elastic at the competitive wage rate

• Firms would be foolish to offer higher wages• Firm could not attract labor at lower wages

– One firm (monopsony) or few firms (oligopsony) OR wage makers: the firm faces an upward sloping supply curve of labor

• Firm hires more labor it must raise wages for new as well as current laborers. Thus MFC (marginal factor cost) > W

• Firm hires less labor wages of all workers fall so MFC > W.

Figure 2.11 Supply of Secretaries to a Firm at Alternative Market

Wages

Market Clearing Wage

• Putting market labor demand and supply together gives the equilibrium wage and amount of labor hired.

• Surplus and shortage of labor and effects on the actual wage rate.

• Comparative statics:– Shifts in demand

• Prices of other inputs• Productivity• Technology• Price of output

– Shifts in Supply• Changes in relative wages (Egypt vs. Saudi Arabia)• Changes in population (aging of the Japanese population)

Figure 2.12 Market Demand and Supply

Figure 2.13 Demand and Supply at the “Market”

and “Firm” Level

Figure 2.14 New Labor Market Equilibrium after Demand Shifts

Right

Figure 2.16 New Labor Market Equilibrium after Supply Shifts

Right

• Dynamic Adjustment– Shortages and surpluses– Labor services cannot be separated from the worker

allows for labor immobility, time lags in investing in human capital, and efficiency wages

– Non-market influences that impede adjustment include laws (minimum wage), customs (child labor, or institutions (unions).

– Asymmetry between wages increases and decreases– Unemployment, persistent disequilibrium at above

market clearing wages.

Policy Questions• Overpaid and underpaid?

– Wages above the equilibrium level• Wages falling would lower cost and raise output →increases in

efficiency• More worker want jobs than can find them →unemployment and less

output for consumers at higher prices• Bus cleaners in Houston – new cleaners paid lower wage → Pareto-

improving

– Wages below the equilibrium level• Wages rising would increase the quantity supplied of labor and

decrease the quantity demanded of labor. More of the good would be produced. Costs would reflect the “true” cost of producing a product.

• Military • Jury Duty

Figure 2.17 Effects of an Above-Equilibrium Wage

Figure 2.18 Effects of a Below-Equilibrium Wage

Figure 2.19 Labor Supply to the Military: Different Preferences

Imply Different “Rents”

• Supply curve as reservation wages and demand curve as maximum wage businesses are willing to pay.– Economic rent is the amount paid to a factor of

production over and above what is necessary to bring it to market

– In the labor market, it is the difference between what workers are paid and their reservation wage

International Differences in Unemployment

• Non-market forces in Europe– High unemployment insurance (see reading)

– Increases in unemployment rate of less-educated/lower-skilled workers given the structural shifts towards high-tech.

• US and Canada wages fell and unemployment rose slightly

• France and Germany wage rates rose and unemployment rose significantly.